Accounting: Stalking the Big Four; Scandals have given Chinese accounting a toxic reputation internationally

April 16, 2013 7:18 pm

Accounting: Stalking the Big Four

By Adam Jones and Simon Rabinovitch

Homegrown auditors are eroding the influence of established western firms in China

China Big Four

When Zhang Ke left Coopers & Lybrand in 1999 to set up his own accounting firm, some doubted the upstart would survive. Outside Coopers – now part of PwC – and the other big western outfits, the profession in China was weak. This did not deter Mr Zhang. “I thought China was so big, it should have some of its own accounting firms,” he recalls. Little more than a decade later, the gamble has paid off. ShineWing, the firm he started, is snapping at the heels of the industry’s biggest names in China and the avuncular, soft-spoken Mr Zhang has become perhaps the most influential accountant in the land. “He is the dean of the accounting profession right now in China,” says Paul Gillis, a professor at Peking University. “He’s the guy.” Such praise will be hard to swallow in some quarters. Scandals have given Chinese accounting a toxic reputation internationally. Instead of Zhang Ke, the name on the lips of many western investors is Muddy Waters, the research firm that has levelled accounting fraud accusations against several Chinese companies. Carson Block, Muddy Waters’ founder, has said questionable auditing is endemic in the fast-growing Chinese market. But even as weaknesses continue to be exposed in the way accounts are drawn up and vetted in China, a subtler trend has emerged. The local dominance of the world’s leading audit and consulting networks – PwC, Deloitte, Ernst & Young and KPMG – is being eroded by ShineWing and other homegrown rivals after two lucrative decades.The accounting upstarts are a fresh example of how China is trying to move up the value chain into more sophisticated products and services after coming to dominate low-cost manufacturing.

Yet the power shift also has international implications: the country’s size and growth trajectory mean that what happens in China could have a global impact on the audit industry and, by extension, the financial markets for which it acts as a gatekeeper.

For all its faults, Chinese accountancy has already come a long way over the past three decades. The profession was dismantled after the founding of the People’s Republic in 1949. The process of putting it back together again began in the 1980s when China cautiously opened its doors to foreign investors.

As part of this revival, the leading western accountants – then the “Big Six” rather than the “Big Four” – were allowed to set up joint ventures with local bodies in the early 1990s. “They had nothing in China to build on after the Cultural Revolution. They had to start again by letting the Big Six come in and train people and write manuals,” says Richard Macve, a London School of Economics professor.

After cutting his teeth at a state-run auditing firm, Mr Zhang ended up at the Coopers & Lybrand joint venture, but he disagreed with foreign colleagues over strategy. Expatriate partners would focus on international clients, he says, then admit at the end of their two to three-year tour of duty that it would have been cleverer to woo the Chinese businesses Mr Zhang had wanted to cultivate.

“Then the next partner would come through and it would be the same process all over again. By the third time, I got fed up with it,” he explains.

After quitting as the joint venture’s managing partner to set up Shine­Wing, he was careful not to challenge his former employer head-on, picking up Chinese clients a rung below those targeted by the western outfits.

Now, aided by the government’s desire for national champions, ShineWing employs about 3,500 people and is one of the top five homegrown firms, according to an annual ranking by the Chinese Institute of Certified Public Accountants (CICPA).

The growth remains rapid enough to complicate the task of handing out business cards for Mr Zhang. The first he proffers has to be swapped with one that is more up to date – but still missing two new outposts.

ShineWing has avoided the scandals dogging Chinese companies that listed abroad via “reverse mergers”, such as Sino-Forest and China MediaExpress.

These businesses took a backdoor route into international capital markets by buying listed shell companies, avoiding the scrutiny of an initial public offering of shares. Nearly 50 have been deregistered by the Securities and Exchange Commission, the US regulator.

Perhaps surprisingly, nearly three-quarters of Chinese reverse merger companies in the US were audited by US firms – mostly smaller outfits – according to 2011 research by the Public Company Accounting Oversight Board, the US audit regulator.

Most of the domestic Chinese challengers making inroads into the dominance of theBig Four are affiliated with second-tier international accounting networks, such as BDO, Crowe Horwath and RSM.

They include Zhonghui, a top tax adviser, which boasts of luring staff from the Big Four with fat salaries, fancy offices and promises of influence. “We say, what are you doing at the Big Four? Even if you make it to partner, you’ll only be a partner with a small responsibility. But with us, you’ll be at the core of our firm,” says Yu Qiang, a managing partner.

The 10 biggest local firms outside the Big Four increased their revenues 38 per cent in 2011, according to the CICPA. Mergers between Chinese firms, encouraged by the state, ac­counted for part of this. By contrast, the Big Four’s revenues rose just 6 per cent. The Big Four’s share of the fees garnered by the top 100 Chinese firms peaked at 55 per cent in 2007 and had slipped to 36 per cent in 2011.

“If you extrapolate the current growth trends, my belief is that, if not this year, then maybe in the next two years, the top four in China will no longer be the global Big Four,” says James Lee, head of the China arm of the Institute of Chartered Accountants in England and Wales, a training body active in the country.

Prof Gillis believes the Big Four will not grow any faster than the Chinese economy: “The great years of growth for the Big Four were the last decade.”

Predictions of a continued power shift reflect a belief that Chinese companies expanding abroad will pass work to trusted Chinese auditors and consultants outside the Big Four, giving them heft to secure more clients.

The same virtuous circle helped the Big Four grow on the back of US might many decades ago; now it could nibble away at their colossal global market share, estimated at 67 per cent by International Accounting Bulletin.

This dominance is a concern for some regulators in the west, who fear market panic if one of the quartet were to collapse in the manner of Arthur Andersen, Enron’s auditor, which failed in the wake of a criminal indictment a decade ago.

The insider trading scandal at KPMG this month was a reminder that an auditor’s all-important reputation can be easily destroyed, while also fuelling fears that the Big Four are too few to fail – and therefore too big to regulate properly.

The viability of Chinese expansion abroad is being tested by ShineWing. Unusually, it has expanded on its own into Australia, Singapore and Japan. “Our main clients, the big listed companies and state-owned enterprises, are going abroad. We have to follow,” says Mr Zhang.

The Australian move involved an alliance with Hall Chadwick, a group of local accounting firms, and followed the acquisition of an Australian group, Felix Resources, by Yanzhou Coal Mining, one of ShineWing’s bigger Chinese clients.

This expansion in Australia “sent a real message to the accounting and audit industry about China’s intent”, according to Geoff Barnes, chief executive of Baker Tilly International, a second-tier global auditor.

Mr Zhang plays down the hyperbole: “We can just go step by step. It might be extremely slow.”

There is indeed widespread scepticism about this go-it-alone strategy abroad. Raymund Chao, PwC’s head of auditing in Asia Pacific, says: “To build a network of a size anywhere close to the existing Big Four, that’s a real challenge.”

. . .

But there is another way in which Chinese auditors could reshape the global market: through large-scale M&A activity, with the financial backing of the country’s state-run banks.

Even without any big takeovers abroad, the global market might be opened up further by the actions of the Chinese government, which now requires Chinese state-owned enterprises (SOEs) to change auditors every five years. This “mandatory rotation” is something regulators in Europe and the US are considering as a way of making auditors more independent, following criticism of their failure to predict bank collapses during the financial crisis.

So far, rotation in China has only obliged the biggest SOEs to swap one Big Four firm for another. But other firms may evolve to the point where they win one or more of these complex contracts, Prof Gillis says.

And if the Chinese arm of a second-tier player such as BDO secured a huge SOE such as PetroChina or ICBC, the network’s global standing could be enhanced, he feels. “China has the chance to completely reshape the competitive market for accounting firms.”

The evolution of the market has been complicated by a dispute between US and Chinese regulators over the oversight of Chinese audit firms. The Big Four – and BDO – have been caught in the middle, with Beijing refusing to let foreign officials inspect China-based audit working papers.

Yet there is another reform that suggests the Big Four’s future in China might not be as clouded as smaller rivals would hope. The quartet have recently been obliged to increase the number of mainland Chinese partners at the top of their businesses.

This presents a short-term challenge, given that many of these individuals are relatively inexperienced. In the longer term, however, it could allow the Big Four to position themselves more persuasively as Chinese, giving them a better shot at retaining business.

PwC, the market leader, says the localisation drive merely continues an existing trend, adding that it is not losing market share. “We will continue to grow. The market is big enough for everyone to play,” says Mr Chao.

In the meantime, Mr Zhang and ShineWing will continue expanding. The eye-catching ambition this year is to enter Europe, most probably Germany or the Netherlands. It also wants offices in the Middle East and South Korea.

The aim is not to break into the Big Four but to carve a niche as a second- or third-tier international accountant, Mr Zhang maintains. But he still thinks a global shake-up of this highly concentrated industry is needed: “Having just the Big Four is not fair to the world.”

Additional reporting by Emma Dong

Expansion: The cautious route to domination

China may be flexing its muscles in the world of accountancy but it is doing it in a low-key fashion. Financial reporting scandals at some Chinese companies – coupled with a more general mistrust of the country’s rise – makes branding a tricky issue for the Chinese profession internationally.

A tie-up with a small group of Australian accounting firms has allowed ShineWing, a leading Chinese auditor, to pick up business from Chinese inward investment. The Australian group changed its name from Hall Chadwick to ShineWing Hall Chadwick in 2011 to assist it in this task.

Yet it has had to rebrand more slowly in areas where Chinese power has been controversial, such as in Queensland’s agricultural sector, where some were angered by the sale of a huge cotton farm to a consortium led by Shandong Ruyi, a Chinese textile maker.

“We are tending to utilise a two-name strategy there,” says David Fairfull, ShineWing Hall Chadwick chairman.

Zhang Ke, ShineWing’s chairman, is eyeing further international expansion in Europe, the Middle East and South Korea. He does not want ShineWing to be viewed as Chinese as it enters new markets: “We want to be like PwC, whose national identity is much less prominent.”

The sensitivity over branding might ease, though, making “Chinese-ness” more of a marketing asset.

The top auditors – PwC, Deloitte, Ernst & Young and KPMG – are notoriously hard to tell apart. A Chinese competitor would have a clear point of difference to emphasise in a world increasingly tilting to the east.

Paul Gillis, a professor at Peking University, wonders if a second-tier rival such as BDO might incorporate a Chinese name into its global brand, in the same way that Deloitte’s global entity is Deloitte Touche Tohmatsu, reflecting the contribution made by its Japanese member firm.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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